LGL Group (LGL) – Pending Asset Sale – 20% upside

Current Price – $5.5

Expected Price –  $6.7

Upside – 20%

Expiration Date – TBD

 

This is a fairly straightforward idea with potential near term catalyst. LGL has received $14m non-binding acquisition proposal for all of its operating assets. If this transaction is closed, then company will become cash shell with c. $6.7/share in cash. Shares are currently trading at pre-announcement levels (acquisition proposal was revealed on the 5th of Oct) and I would expect shares to re-rate if acquisition is confirmed.

Controlling shareholder (Gabelli family) just increased the stake 2x by oversubscribing to the rights offering and buying shares at $5.5/share – same price as currently.

Further points:

  • Current cash per share stands at $3.46;
  • Company has $10m in federal and $16m in state NOLs – part of this will likely be utilized to cover any taxable gains form the sale of operating businesses;
  • Recent share price volatility was affected by the rights offering (at $5.5/share) as well as acquisition prososal. Rights offering was announced back in August at a premium to market price and then extended twice due to the acquisition proposal. Rights offering expired on 13th of November and 1.7m new shares were issued for total gross proceeds of $9.4m.
  • Gabelli family owned 32% of the stock prior to the rights offering and likely were the main participants in the rights offering. Beneficial ownership of Mario Gabelli increased from 0.46m shares to 1.43m shares - $5.2m of additional funds invested – resulting in 33% ownership. Marc Gabelli’s participation in the rights offering has not been announced yet, but he had 14% stake before, so I assume he participated at least to the level where Gabelli family would reach 50% controlling interest.
  • Operating businesses (design and manufacturing of frequency and spectrum control products for aerospace and defense industries) are growing and generate positive (albeit minimal) operating cashflows.
  • So far there has been no further update neither from the company not from potential acquirers regarding the transaction.
  • Eventual cash per share will potentially be slightly lower than the $6.7, as fees will need to be deducted on the rights offering proceeds and asset sale proceeds might be adjusted for working capital requirements.

I do not know how likely it is for the asset sale to close, but Gabelli family were willing to invest in the company at $5.5/share even before the acquisition proposal was received. Actually the whole rights offering (at premium to market price) seemed to have been designed for the sole purpose of increasing Gabelli family stake.

 

25 COMMENTS

  1. Eric S

    How confident are you in the wording on this deal? “Cash-free, debt-free” deal could imply they are taking both. They refer to “enterprise value” which is a measure that includes cash and debt. If they weren’t taking the pre-rights cash (>2m), wouldn’t they just say for “cash consideration”?

    1. dt

      My understanding is the opposite – any cash and debt outside of normal working capital requirements would remain with LGL.

    1. dt

      They will use cash to make further investments in order to utilize NOLs.
      I think there is zero chance that cash would be distributed to shareholder, especially keeping in mind that Gabelli family just went though the rights process to inject more cash into the company.

  2. H Choi

    Thank you for the idea. New user here and I have a few questions – the offering increases the outstanding share to 4.4m. I can see that the $6.7 cash / share is based on this figure. But how does the increased number of shares come in to play? Would it not impact the current $5.75 price (on an ex-rights basis)?

    1. dt

      Rights offering already expired and new shares have been distributed (majority of them to Gabelli family, who will not be selling in the open market).

      So the current market trading already reflects that information.

  3. Noah Kauffman

    Hello – thanks to whomever posted this idea – it is quite interesting. However i think you maybe over estimating the use of those NOLS. According to section 382 the IRS highly restricts their use in the event of change of control. Not sure the percentage that is triggered to invalidate its use but i assume while the NOLS could probably be used to offset capital gains on asset divestiture that they almost certainly cannot be used to offset gains from future transactions post the merger. Pls correct me if i am wrong but if this weren’t true profitable companies would frequently merge with bankrupt coal companies to utilize these. The only recent case I’m aware of someone potentially finding a loophole is with GLRE’s BIOF which merged with one of einhorn’s friend who ran a residential real estate company. Not sure of the outcome there but doubt they were able to use them.

    1. dt

      Noah, I am not tax expert and this was just my speculation that NOLs could be used to offset any gain on sale of operating subsidiaries. I assumed there is no change of control as not the parent but rather subsidiaries are sold and therefore NOLs are preserved. But I might be wrong, so any further clarifications are welcome.

      Gabelli family are experts on tax plays and it is likely they see a way to utilize NOLs (maybe not through subsidiary sale), otherwise I doubt they would have participated in the rights offering so actively.

      After the rights offering Gabelli family ownership increased from 32% to 43% (additional $6.4m invested) and rights offering was oversubscribed with over subscription allocations were prorated.

      http://www.nasdaq.com/press-release/lgl-announces-updates-to-results-of-rights-offering-to-account-for-oversubscriptions-20171117-00898

  4. greg lia

    I would gladly place my bet alongside Gabelli on this one as their should be no secret his goal will be to get a quick profitable deal done. Unfortunately the anemic volume and bid ask spread have not presented an entry point acceptable to me.

  5. Fernando

    Someone correct me if I’m wrong but his looks like a trick from Gabelli that enables him to control the company but still to utilize the NOLs. In this case he managed to control the company without legally having triggered a ‘change of control’. He did this by the fact that is brother is a significant shareholder and board member as well

    1. dt

      Still an active idea and I am still a shareholder. There have been no further updates regarding sale of the operating assets, so I assume it is off the table.
      - Cash + marketable securities stand at $3.63/share;
      - Non-binding offer valued operating assets at $3.6/share;
      - Gabelli family just infused $6m in the company at $5.5/share and own 35%;
      - Business is growing and cashflow positive;

      I think downside risk is quite low here and upside optionality significant.

      1. mcg mcg

        For what its worth- LGL is obligated to disclose the termination of the asset sale discussions in an 8-K and they have not. (Comment from IR)

  6. greg lia

    News out tonight

    https://www.businesswire.com/news/home/20180727005613/en/LGL-Continues-Evaluation-Non-Binding-Acquisition-Proposal-Announces

    I do wonder if LGL was advised or otherwise felt it was prudent, or was obligated to get this news out prior to the expiration of the warrants? Very interesting timing. Also, while I do read this to be Serious in terms of the Proposal being accepted, clearly the cash is not coming to the shareholders, rather likely to be redeployed

    1. dt

      I am a bit puzzled by this. There is no indication whether the discussions with the acquirer are still ongoing and whether the proposal still stands.

      In any case this is definitely non-negative and even if cash is redeployed, i would expect LGL to trade much closer to BV after sale of operating assets.

  7. dt

    Business acquisition proposal has been terminated. At the same time company provided update on Q2 outlook. Company expects to earn $0.09-$0.1 which is a 100% increase sequentially.

    https://www.businesswire.com/news/home/20180731005934/en/LGL-Announces-Termination-Discussions-Investment-Group

    Shares popped up upon the announced and I closed at $5.9. Not the outcome I was expecting, but still a 7% return in 8 months.

    Shares might be interesting as a longer term holding and I might reenter the position after full Q2 results are announced. But the special situation part is closed.

  8. greg lia

    LGl announced this morning they have terminated discussions with the buyers group. Also preannounced second quarter estimated sales, earnings, and backlog. All seemed quite positive. Stock up at the moment

  9. greg lia

    Big move last couple of days. large volume of purchases both open market and exercised warrants by both Marc and Mario Gabelli. I’m somewhat perplexed why someone would exercise a 7.50 warrant with stock at 5.8 but perhaps there are some other considerations associated with the warrants that I’m not aware of. LGL has more or less pre announced earnings so hopefully tomorrow wont be a surprise.

    1. Vincent

      I can only think of two reasons: tax-issues assiociated with the warrants or Gabelli is preparing an offer to buy the rest himself for more then $7.50. But that is probably wishful thinking :) Other then that no idea.

      1. efurey

        I think there are two things accomplished here: first, Gabelli couldn’t buy the quantity he did by going into the market and given the illiquidity may actually have paid a higher price had he attempted to do so and second, the purchase price actually goes into the company through the warrant exercise so there is more cash there to do a deal.

  10. Nathan

    Vincent – can you explain a scenario why one would, for tax reasons, execute the warrants. I don’t follow the logic here.

    1. Vincent

      Hi Nathan, I’m not sure as well but I read from the LGL website Q&A:

      “Question 25. What is my tax basis for the warrants I received or obtained through buying the common stock with due bills attached?
      Generally, if you purchased your LGL common stock after the record date with a due bill attached, your tax basis in the warrants is the fair market value of the warrants at the time that you purchased the common stock.”

      That made me think perhaps it’s possible to make a paper loss, if the tax basis is a lower share price and you buy the stock by exchanging warrants for €7,5. So then maybe it is possible to offset this loss with other shares that show a profit.

      Again, just a guess by me as maybe a possibility, not sure at all how this works exactly.

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